Building Your Business What Are Accruals? By Femi Lewis Femi Lewis Instagram Twitter Website Femi Lewis is a New York-based writer specializing in small business development and digital marketing whose work has been published in media outlets such as Black Enterprise, the South Florida Sun-Sentinel, Fort Worth Star-Telegram, Kansas City Star, Quizlet, and ThoughtCo. She is also the founder of her own content marketing firm, Femi Writes. learn about our editorial policies Updated on July 19, 2022 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Fact checked by Kiran Aditham In This Article View All In This Article Definition and Examples of Accruals How Accruals Work Photo: kate_sept2004 / Getty Images Definition Accruals are income earned or revenues incurred that are recorded as transactions occur rather than when actual payments are made or received by a business. Key Takeaways Accrual accounting is an accounting method that records income and expenses as the transactions occur instead of when payments are received or made. The purpose of accrual accounting is to balance income and expenses within the same period. The accrual method of accounting differs from cash accounting, which records transactions when income is received or payments are made by the business. Businesses that generate under $25 million in annual gross receipts from the three preceding tax years can choose cash accounting over accrual. Definition and Examples of Accruals Accruals, which are the basis of the accrual method of accounting, refer to revenue and expenses recorded in a general ledger as invoices are distributed—not when a payment has been sent or received by a vendor. As payments are made, entries are adjusted as a paid expense or income received. Accrual income is reported as gross income when: A business receives a payment Income is due to be paid to a business When a business earns revenueIf a title (on the property) is passed on to the business as part of a transaction In contrast, an accountant or bookkeeper can defer accrued expenses when: Services or property are provided to clients The business has recovered a liability Note Businesses that produce or sell merchandise and maintain inventory (i.e. retailers) must use the accrual method for purchases and sales unless they qualify for the Exception for Small Business Taxpayers. Example of Accrued Revenue Accrued revenue is income that’s earned by the business but has yet to be billed to or received from the client or customer. An example of accrual of revenues would be a contractor completing a job for a homeowner. Throughout December, the contractor is completing work for their client. However, the contractor does not send an invoice until all work has been completed. The client would receive their bill in January. The contractor adjusts its financial statement so that: Income for December and the new year will be reported as earned by the contractorThe Dec. 31 balance sheet will include the income the contractor should expect to receive from all clients. Example of Accrued Expense An accrued expense refers to any liabilities, losses, or ongoing accounts payable that have not yet been recorded. An example of an accrued expense would be a landlord of a large building replacing the boiler in December—the last month of an accounting year. However, the company, or tenant, will not pay the bill until an invoice is received in January. Using the accrual method, a bookkeeper or accountant must: Record the liability or expense on the balance sheet in the previous year. Report the repair and its expense on the income statement for the current year. A business’s expenses can include any costs related to running the company such as rent, utilities, office supplies, property, equipment, and payroll. How Accruals Work In the accrual method of accounting, businesses will report income in the year it is earned, while expenses will also be recorded in the year they were incurred. The purpose of accruals is to ensure that businesses match their income and expenses accurately within an accounting year. Note Business accounting software can help entrepreneurs monitor their accrued accounts. Tax Implications In terms of taxes, accrual accounting requires companies to pay taxes on income that is still owed, meaning you generally report income in the tax year you earn it, regardless of when payment is received. The same goes for expenses, which you deduct in the tax year you incur them, regardless of when payment is made. Small businesses such as microbusinesses and sole proprietorships that file individual taxes and likely earn less revenue than corporations and partnerships do not have to use accrual accounting to manage their finances. Under the 2017 Tax Cuts and Jobs Act, the IRS allows small businesses generating less than $25 million in annual gross receipts from the three previous tax years that are not in a tax shelter to opt for cash accounting instead of accrual. Note If you choose to change your accounting method to use the accrual accounting method, your business must file Form 3115 for IRS approval. While accrual accounting may be considered a more complex method than cash accounting, it can provide bookkeepers and accountants with a more accurate long-term view of a business’s finances. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Internal Reveune Service. "Publication 538 Accounting Periods and Methods," Page 10. Internal Revenue Service. "Publication 538 Accounting Periods and Methods." Internal Revenue Service. "IRS Issues Guidance on Small Business Accounting Method Changes Under Tax Cuts and Jobs Act."